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LCNB CORP - Quarter Report: 2004 September (Form 10-Q)

UNITED STATES




UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.   20549


FORM 10-Q


(Mark One)


(  X  )

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended September 30, 2004


 (      )

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934


For the transition period from

  to  



Commission File Number  000-26121



LCNB Corp.

(Exact name of registrant as specified in its charter)


Ohio

 31-1626393

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification Number)


2 North Broadway, Lebanon, Ohio   45036

(Address of principal executive offices, including Zip Code)


(513) 932-1414

(Registrant's telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.


Yes   X  No   


Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).


Yes   X  No   



The number of shares outstanding of the issuer's common stock, without par value, as of October 27, 2004 was 3,331,299 shares.






LCNB Corp.


INDEX

Page No.


Part I - Financial Information


Item 1.  Financial Statements


Consolidated Balance Sheets -

September 30, 2004, and December 31, 2003

1


Consolidated Statements of Income -

Three and Nine Months Ended September 30, 2004 and 2003

2


Consolidated Statements of Comprehensive Income -

Three and Nine Months Ended September 30, 2004 and 2003

3


Consolidated Statements of Stockholders' Equity -

Nine Months Ended September 30, 2004 and 2003

4


Consolidated Statements of Cash Flows -

Nine Months Ended September 30, 2004 and 2003

5


Notes to Consolidated Financial Statements

6-12


Independent Accountants' Review Report

13


Item 2.  Management's Discussion and Analysis of Financial

Condition and Results of Operations

14-27


Item 3.  Quantitative and Qualitative Disclosures about

Market Risks

28


Item 4  Controls and Procedures

28


Part II - Other Information


Item 1  Legal Proceedings

29


Item 2  Changes in Securities and Use of Proceeds

29-30


Item 3  Defaults by the Company on its Senior Securities

30


Item 4  Submission of Matters to a Vote of Security Holders

30


Item 5  Other Information

30


Item 6  Exhibits and Reports on Form 8-K

31


Signatures

32











LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 
 
  

September 30,

 

December 31,

  

2004

 

2003

  

( Unaudited )

  

ASSETS:

        

   Cash and due from banks

 

$

15,451 

   

11,784 

 

   Federal funds sold

  

13,575 

   

22,625 

 

        Total cash and cash equivalents

  

29,026 

   

34,409 

 
         

   Securities available for sale, at market value

  

133,256 

   

150,939 

 

   Federal Reserve Bank stock and Federal Home

     Loan Bank stock, at cost

  


3,033 

   


2,962 

 

   Loans, net

  

334,214 

   

315,683 

 

   Premises and equipment, net

  

12,264 

   

12,009 

 

   Intangibles, net

  

2,337 

   

2,832 

 

   Other assets

  

5,074 

   

4,774 

 

            TOTAL ASSETS

 

$

519,204 

   

523,608 

 
         

LIABILITIES

        

   Deposits -

        

    Noninterest-bearing

 

$

74,314 

   

66,159 

 

    Interest-bearing

  

385,263 

   

396,874 

 

        Total deposits

  

459,577 

   

463,033 

 

   Long-term debt

  

4,152 

   

4,197 

 

   Accrued interest and other liabilities

  

3,389 

   

3,930 

 

            TOTAL LIABILITIES

  

467,118 

   

471,160 

 
         

SHAREHOLDERS' EQUITY

        

   Common stock-no par value, authorized 4,000,000

     shares; issued and outstanding 3,551,884 shares

  


10,560 

   


10,560 

 

   Surplus

  

10,553 

   

10,553 

 

   Retained earnings

  

35,871 

   

33,872 

 

   Treasury shares at cost, 220,585 and 177,508 shares

     at September 30, 2004 and December 31, 2003,   

     respectively

  



(5,966)

   



(4,356)

 

   Accumulated other comprehensive income ,

     net of taxes

  


1,068 

   


1,819 

 

            TOTAL SHAREHOLDERS' EQUITY

  

52,086 

   

52,448 

 
         

            TOTAL LIABILITES AND

               SHARESHOLDERS' EQUITY

 


$


519,204 

   


523,608 

 
         
         
         

The accompanying notes to the consolidated financial statements are an integral part of these statements .

         

- 1 -













 











LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED  STATEMENTS OF INCOME

(In thousands except share and per share data)

(Unaudited)

 
  

Three Months Ended

 

Nine Months Ended

  

September 30,

 

September 30,

  

2004

 

2003

 

2004

 

2003

INTEREST INCOME:

        

   Interest and fees on loans

$

5,187

 

5,325

 

15,250

 

16,633

   Dividends on Federal Reserve Bank

     and Federal Home Loan Bank stock

 


25

 


23

 


91

 


87

   Interest on investment securities-

        

       Taxable

 

734

 

741

 

2,204

 

2,245

       Non-taxable

 

484

 

532

 

1,457

 

1,595

   Other short-term investments

 

28

 

40

 

94

 

132

        TOTAL INTEREST INCOME

 

6,458

 

6,661

 

19,096

 

20,692

         

INTEREST EXPENSE:

        

   Interest on deposits

 

1,771

 

1,978

 

5,274

 

6,489

   Interest on borrowings

 

55

 

74

 

162

 

216

        TOTAL INTEREST EXPENSE

 

1,826

 

2,052

 

5,436

 

6,705

           NET INTEREST INCOME

 

4,632

 

4,609

 

13,660

 

13,987

   PROVISION FOR LOAN LOSSES

 

130

 

204

 

430

 

421

         

        NET INTEREST INCOME AFTER

          PROVISION FOR LOAN LOSSES

 


4,502

 


4,405

 


13,230

 


13,566

         

NON-INTEREST INCOME:

        

   Trust income

 

365

 

268

 

1,080

 

757

   Service charges and fees

 

980

 

827

 

2,850

 

2,166

   Net gain on sales of securities

 

9

 

3

 

136

 

3

   Insurance agency income

 

333

 

307

 

1,061

 

1,067

   Gains from sales of mortgage loans

 

5

 

233

 

47

 

735

   Gain from sale of credit card portfolio

 

-

 

-

 

403

 

-

   Other operating income

 

30

 

38

 

99

 

103

        TOTAL NON-INTEREST INCOME

 

1,722

 

1,676

 

5,676

 

4,831

         

NON-INTEREST EXPENSE:

        

   Salaries and wages

 

1,732

 

1,744

 

5,239

 

5,155

   Pension and other employee benefits

 

454

 

418

 

1,416

 

1,314

   Equipment expenses

 

256

 

262

 

769

 

748

   Occupancy expense – net

 

303

 

281

 

900

 

830

   State franchise tax

 

143

 

133

 

427

 

396

   Marketing

 

112

 

124

 

320

 

284

   Intangible amortization

 

149

 

154

 

450

 

456

   ATM expense

 

78

 

76

 

230

 

219

   Other non-interest expense

 

825

 

845

 

2,578

 

2,445

        TOTAL NON-INTEREST EXPENSE

 

4,052

 

4,037

 

12,329

 

11,847

         

        INCOME BEFORE INCOME

         TAXES

 


2,172

 


2,044

 


6,577

 


6,550

PROVISION FOR INCOME TAXES

 

590

 

518

 

1,777

 

1,720

        NET INCOME

$

1,582

 

1,526

 

4,800

 

4,830

         

Dividends declared per common share

$

0.2800

 

0.2625

 

0.8350

 

0.7875

         

Earnings per common share:

        

   Basic

$

0.47

 

0.45

 

1.43

 

1.41

   Diluted

 

0.47

 

0.45

 

1.43

 

1.41

         

Average shares outstanding:

        

   Basic

 

3,339,521

 

3,415,380

 

3,358,429

 

3,431,112

   Diluted

 

3,340,774

 

3,416,062

 

3,359,530

 

3,431,350

         
         
         

The accompanying notes to consolidated financial statements are an integral part of these statements.

         

- 2 -














LCNB CORP. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

(In thousands)

 

(Unaudited)

 
            
   

Three Months Ended

  

Nine Months Ended

 
   

September 30,

  

September 30,

 
   

2004

 

2003

  

2004

 

2003

 
            

Net Income

 

$

1,582 

 

1,526 

  

4,800 

 

4,830 

 
            

Other comprehensive income (loss):

           

   Net unrealized gain (loss) on available

           

     for sale securities (net of taxes of

           

     $616 and a tax benefit of $340 for the

           

     three and nine months ended

           

     September 30, 2004, and net of tax

           

     benefits of $804 and $155 for the

           

     three and nine months ended

           

     September 30, 2003)

  

1,193 

 

(1,561)

  

(661)

 

(300)

 
            

   Reclassification adjustment for net

           

     realized gain on sale of available for

           

     sale securities included in net income

           

     (net of taxes of $3 and $46 for the

           

     three and nine months ended

           

     September 30, 2004, and net of taxes

           

     of $1 and $1 for the three and nine

           

     months ended September 30, 2003)

  

(5)

 

(2)

  

(90)

 

(2)

 
            

       TOTAL COMPREHENSIVE

           

          INCOME (LOSS)

 

$

2,770 

 

(37)

  

4,049 

 

4,528 

 
            
            
            

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

- 3 -















LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

( In thousands )

(Unaudited)

                 
          

Accumulated

    
          

Other

  

Total

 
  

Common

   

Retained

 

Treasury

 

Comprehensive

 

Shareholders'

  

Shares

 

Surplus

 

Earnings

 

Shares

 

Income

  

Equity

 
                 

Balance January 1, 2003

$

10,560

 

10,553

 

30,768 

 

(2,193)

  

2,242 

   

51,930 

 
                 

Net income

     

4,830 

        

4,830 

 
                 

Change in estimated fair value of securities available for sale, net of tax and reclassification adjustment

          



(302)

   



(302)

 
                 

Treasury shares purchased

       

(2,021)

      

(2,021)

 
                 

Cash dividends declared

     

(2,705)

        

(2,705)

 
                 

Balance September 30, 2003

$

10,560

 

10,553

 

32,893 

 

(4,214)

  

1,940 

   

51,732 

 
                 
                 

Balance January 1, 2004

$

10,560

 

10,553

 

33,872 

 

(4,356)

  

1,819 

   

52,448 

 
                 

Net income

     

4,800 

        

4,800 

 
                 

Change in estimated fair value of securities available for sale, net of tax and reclassification adjustment

          



(751)

   



(751)

 
                 

Treasury shares purchased

       

(1,610)

      

(1,610)

 
                 

Cash dividends declared

     

(2,801)

        

(2,801)

 
                 

Balance September 30, 2004

$

10,560

 

10,553

 

35,871 

 

(5,966)

  

1,068 

   

52,086 

 
                 
                 
                 

The accompanying notes to consolidated financial statements are an integral part of these statements.

                 

- 4 -
















LCNB CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

( In thousands)

(Unaudited)

 
  

Nine Months Ended

  

September 30,

  

2004

 

2003

CASH FLOWS FROM OPERATING ACTIVITIES:

    

   Net income

$

4,800 

 

4,830 

   Adjustments to reconcile net income to net cash provided

    by operating activities-

    

      Depreciation, amortization and accretion

 

2,291 

 

2,370 

      Provision for loan losses

 

430 

 

421 


 


 

 

      Federal Home Loan Bank stock dividends

 

(71)

 

(67)

      Realized gains on sales of securities available for sale

 

(136)

 

(3)

      Realized gain on sale of credit card portfolio

 

(403)

 

      Origination of mortgage loans for sale

 

(1,843)

 

(33,900)

      Realized gains from sales of mortgage loans

 

(47)

 

(735)

      Proceeds from sales of mortgage loans

 

1,869 

 

34,276 

      (Increase) decrease in income receivable

 

116 

 

(60)

      (Increase) decrease in other assets

 

(416)

 

53  

      Increase (decrease) in other liabilities

 

(150)

 

( 95 )

         TOTAL ADJUSTMENTS

 

1,640 

 

2,2 60  

     

            NET CASH PROVIDED BY OPERATING ACTIVITIES

 

6,440 

 

7,0 90  

     

CASH FLOWS FROM INVESTING ACTIVITIES:

    

   Proceeds from sales of securities available for sale

 

16,029 

 

1,775 

   Proceeds from maturities of securities available for sale

 

30,192 

 

36,054 

   Purchase of securities available for sale

 

(30,284)

 

(50,004)

   Proceeds from sale of credit card portfolio

 

2,927 

 

   Net decrease (increase) in loans

 

(21,705)

 

6,493 

   Purchases of premises and equipment

 

(1,06 6 )

 

(897)


 


 


            NET CASH USED IN INVESTING ACTIVITIES

 

(3,907)

 

(6,5 79 )

     

CASH FLOWS FROM FINANCING ACTIVITIES:

    

   Net change in deposits

 

(3,456)

 

18,159 

   Net change in short-term borrowings

 

(4)

 

(2,637)

   Principal payments on long-term debt

 

(45)

 

(42)

   Cash dividends paid

 

(2,801)

 

(2,705)

   Purchases of treasury shares

 

(1,610)

 

(2,021)

            NET CASH PROVIDED BY FINANCING ACTIVITIES

 

(7,916)

 

10,754 

     

            NET CHANGE IN CASH AND CASH EQUIVALENTS

 

(5,383)

 

11,265 

     
     

CASH AND CASH EQUIVALENTS AT BEGINNING

   OF PERIOD

 


34,409 

 


25,604 

     

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$

29,026 

 

36,869 

     

SUPPLEMENTAL CASH FLOW INFORMATION:

    
     

CASH PAID DURING THE YEAR FOR:

    

   Interest paid

$

5,512 

 

6,858 

   Income tax paid

 

1,806 

 

1,720 

     
     
     

The accompanying notes to consolidated financial statements are an integral part of these statements.

     

- 5 -

















LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)



Note 1 - Basis of Presentation

Substantially all of the assets, liabilities and operations of LCNB Corp.("LCNB") are attributable to its wholly owned subsidiaries, Lebanon Citizens National Bank ("Lebanon Citizens") and Dakin Insurance Agency, Inc. ("Dakin").  The accompanying unaudited consolidated financial statements include the accounts of LCNB, Lebanon Citizens, and Dakin.


The statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, the unaudited consolidated financial statements include all adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation of financial position, results of operations, and cash flows for the interim periods.


The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.


Results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year ending December 31, 2004.  These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements, accounting policies and financial notes thereto included in LCNB's 2003 Form 10-K filed with the Securities and Exchange Commission.


The Board of Directors of LCNB at the regular meeting of April 13, 2004 declared a stock dividend of one share for each share owned to shareholders of record on April 20, 2004.  The stock dividend was paid on April 30, 2004 and was accounted for as a stock split.  All share and per share information for all periods presented have been retroactively restated to reflect the stock dividend.


The financial information presented on pages one through twelve of this Form 10-Q has been subject to a review by J.D. Cloud & Co. L.L.P., LCNB's independent certified public accountants, as described in their report contained herein.



- 6 -














LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)



Note 2 - Earnings Per Share

Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is adjusted for the dilutive effects of stock options.  The diluted average number of common shares outstanding has been increased for the assumed exercise of stock options with proceeds used to purchase treasury shares at the average market price for the period.  The computations were as follows for the three and nine months ended September 30 (thousands, except share and per share data):


  

For the Three Months

 

For the Nine Months

  

Ended September 30,

 

Ended September 30,

  

2004

 

2003

 

2004

 

2003

         

Net income

$

1,582

 

1,526

 

4,800

 

4,830

         

Weighted average number of shares

 outstanding used in the calculation of

 basic earnings per common share

 



3,339,521

 



3,415,380

 



3,358,429

 



3,431,112

         

Add- Dilutive effect of stock options

 

1,253

 

682

 

1,101

 

238

         

Adjusted weighted average number

 of shares outstanding used in the

 calculation of diluted earnings per

 common share

 




3,340,774

 




3,416,062

 




3,359,530

 




3,431,350

         

Basic earnings per common share

$

0.47

 

0.45

 

1.43

 

1.41

         

Diluted earnings per common share

$

0.47

 

0.45

 

1.43

 

1.41

         


Note 3 -  Investment Securities

The amortized cost and estimated market value of available-for-sale investment securities at September 30, 2004 and December 31, 2003 are summarized as follows (thousands):

 

 

September 30, 2004

  

Amortized

Cost

 

Unrealized

Gains

 

Unrealized

Losses

 

Market

Value

 

U.S. Treasury notes

$

3,148

 

14

 

-

 

3,162

 

U.S. Agency notes

 

35,219

 

196

 

113

 

35,302

 

U.S. Agency mortgage-backed securities

 

28,580

 

162

 

199

 

28,543

 

Municipal securities:

         

     Non-taxable

 

52,460

 

1,433

 

33

 

53,860

 

     Taxable

 

12,230

 

208

 

49

 

12,389

 
 

$

131,637

 

2,013

 

394

 

133,256

 

 

   

- 7 -











LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)



Note 3 – Investment Securities (continued)


 

December 31, 2003

  

Amortized

Cost

 

Unrealized

Gains

 

Unrealized

Losses

 

Market

Value

 

U.S. Treasury notes

$

2,137

 

12

 

-

 

2,149

 

U.S. Agency notes

 

61,397

 

608

 

183

 

61,822

 

U.S. Agency mortgage-backed securities

 

20,951

 

158

 

121

 

20,988

 

Municipal securities:

         

     Non-taxable

 

52,441

 

2,002

 

34

 

54,409

 

     Taxable

 

11,258

 

357

 

44

 

11,571

 
 

$

148,184

 

3,137

 

382

 

150,939

 



Note 4 - Loans

Major classifications of loans at September 30, 2004 and December 31, 2003 are as follows (thousands):


  

September 30,

 

December 31,

   

2004

   

2003

 
         

Commercial and industrial

 

$

37,038 

   

30,519 

 

Commercial, secured by real estate

  

102,725 

   

99,461 

 

Residential real estate

  

156,136 

   

139,305 

 

Consumer, excluding credit card

  

36,923 

   

43,283 

 

Agricultural

  

2,435 

   

1,192 

 

Credit card

  

   

2,707 

 

Other loans

  

265 

   

212 

 

Lease financing

  

299 

   

588 

 
   

335,829 

   

317,267 

 

Deferred net origination costs

  

535 

   

566 

 
   

336,364 

   

317,833 

 

Allowance for loan losses

  

(2,150)

   

(2,150)

 

      Loans – net

 

$

334,214 

   

315,683 

 
         


Mortgage loans sold to and serviced for the Federal Home Loan Mortgage Corporation ("FHLMC") are not included in the accompanying balance sheets.  The unpaid principal balances of those loans at September 30, 2004 and December 31, 2003 were $47,705,000 and $54,802,000, respectively.  Loans sold to the FHLMC during the three and nine months ended September 30, 2004 totaled $178,000 and $1,843,000, respectively, and $11,785,000 and $33,900,000 during the three and nine months ended September 30, 2003, respectively.




- 8 -












LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)



Note 4 - Loans (continued)

Mortgage servicing rights on originated mortgage loans that have been sold are capitalized by allocating the total cost of the loans between mortgage servicing rights and the loans based on their relative fair values.  Approximately $2,000 and $20,000 were capitalized during the three and nine months ended September 30, 2004, respectively, and $139,000 and $359,000 were capitalized during the three and nine months ended September 30, 2003, respectively.  Capitalized mortgage servicing rights are being amortized to loan servicing income in proportion to and over the period of estimated servicing income.


Changes in the allowance for loan losses for the nine months ended September 30, 2004 and 2003 were as follows (thousands):


  

September 30,

 

September 30,

   

2004

   

2003

 
         

Balance - beginning of year

 

$

2,150 

   

2,000 

 

Provision for loan losses

  

430 

   

421 

 

Charge-offs

  

(530)

   

(385)

 

Recoveries

  

100 

   

39 

 

     Balances - end of period

 

$

2,150 

   

2,075 

 


Charge-offs for the nine months ended September 30, 2004 included a $126,000 charge-off for a commercial loan and $32,000 for residential mortgage loans.  The balance of charge-offs for that period was primarily for consumer and credit card loans.  Charge-offs for the nine months ended September 30, 2003 consisted of consumer and credit card loans.  There were no charge-offs on residential real estate or commercial loans for the 2003 period.


Non-accrual, past-due, and restructured loans as of September 30, 2004 and December 31, 2003 were as follows (thousands):


  

September 30,

 

December 31,

   

2004

   

2003

 
         

Non-accrual loans

 

$

1,817

   

794

 

Past-due 90 days or more and still accruing

  

153

   

2,442

 

Restructured loans

  

-

   

-

 

     Total

 

$

1,970

   

3,236

 




- 9 -












LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)



Note 4 - Loans (continued)

Non-accrual loans at September 30, 2004 consisted of related commercial loans that were classified as loans past due 90 days or more and still accruing at December 31, 2003, at which time they had a balance of $2,030,000.  The $213,000 difference in the loan balances at September 30, 2004 and December 31, 2003 is due to principal payments received .  These loans are secured by a combination of mortgages and other collateral.  Information received during the first quarter, 2004 raised uncertainties concerning the collectibility of certain collateral and management transferred the loans to the nonaccrual classification and was continuing to classify the loans as non-accrual at September 30, 2004.  All related interest due on the loans was paid during October, 2004 and the loans were re-written at that time.  Such interest has been recorded on a cash basis as received.


Non-accrual loans at December 31, 2003 included a commercial loan in the amount of $564,000, which was paid in full during the second quarter, 2004.



Note 5 – Other Borrowings

At September 30, 2004 and December 31, 2003, accrued interest and other liabilities included U.S. Treasury demand note borrowings of approximately $629,000 and $633,000, respectively.



Note 6 - Commitments and Contingent Liabilities

LCNB is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit.  They involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.  Exposure to credit loss in the event of nonperformance by the other parties to financial instruments for commitments to extend credit is represented by the contract amount of those instruments.




- 10 -













LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)




Note 6 - Commitments and Contingent Liabilities (continued)

LCNB uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  Financial instruments whose contract amounts represent off-balance-sheet credit risk at September 30, 2004 and December 31, 2003 were as follows (thousands):


  

September 30,

 

December 31,

   

2004

   

2003

 
         

Commitments to extend credit

 

$

67,431

   

74,828

 

Standby letters of credit

  

6, 304

   

6,770

 


Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses.  Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.  At September 30, 2004 and December 31, 2003, outstanding guarantees of $2,101,000 and $1,880,000, respectively, were issued to developers and contractors.  These guarantees generally expire within one year and are fully secured.  In addition, LCNB has a participation  in a letter of credit securing payment of principal and interest on a bond issue.   The participation amount at September 30, 2004 and December 31, 2003 was approximately $4.2 million and $4.9 million, respectively.  The expiration date for t his letter of credit w as extended from July 15, 2006 to July 15, 2009 during the third quarter, 2004.  It is secured by an assignment of rents and the underlying real property.


LCNB evaluates each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the borrower.  Collateral held varies, but may include accounts receivable; inventory; property, plant and equipment; residential realty; and income-producing commercial properties.


At September 30, 2004, LCNB is committed under various contracts to expend approximately $265,000 to complete certain building and office renovation projects.  






















Management believes that LCNB has sufficient liquidity to fund its lending and capital expenditure commitments.


LCNB and its subsidiaries are parties to various claims and proceedings arising in the normal course of business.  Management, after consultation with legal counsel, believes that the liabilities, if any, arising from such proceedings and claims will not be material to the consolidated financial position or results of operations.









- 11 -












LCNB Corp. and Subsidiaries

Notes to the Consolidated Financial Statements

(Unaudited)

(Continued)



Note 7 - Stock Options

LCNB established an Ownership Incentive Plan (the "Plan") during 2002 that allows for stock-based awards to eligible employees.  The awards may be in the form of stock options, share awards, and/or appreciation rights.  The Plan provides for the issuance of up to 100,000 shares.  Stock options for 4,054 shares with an exercise price of $35.315 were granted to key executive officers of LCNB during the first quarter, 2004.  At September 30, 2004, 9,582 stock options with a weighted average exercise price of $30.05 were outstanding.  The options expire in 2013 and 2014.  No options have been exercised as of September 30, 2004.


LCNB accounts for the Plan under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees , and related Interpretations.  No stock-based employee compensation cost is reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.  The pro-forma effect on net income and earnings per share if LCNB had applied the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation , to stock-based employee compensation was not material.  Because 2003 was the first year stock options were outstanding, the pro-forma affect for 2003 and 2004 may not be indicative of the pro-forma affect on future quarters and years.



Note 8 – Employee Benefits

LCNB has a noncontributory defined benefit retirement plan that covers all regular full-time employees.  The components of net periodic pension cost for the three and nine months ended September 30, 2004 and 2003, are summarized as follows (thousands):


  

For the Three Months

 

For the Nine Months

  

Ended September 30,

 

Ended September 30,

  

2004

 

2003

 

2004

 

2003

         

Service cost

$

163,337 

 

147,016 

 

489,477 

 

474,922 

Interest cost

 

63,041 

 

90,704 

 

188,175 

 

207,104 

Expected return on plan assets

 

(66,234)

 

(78,074)

 

(225,416)

 

(235,179)

Amortization on net (gain) loss

 

17,832 

 

(6,859)

 

53,294 

 

42,200 

     Net periodic pension cost

$

177,976 

 

152,787 

 

505,530 

 

489,047 


LCNB previously disclosed in its consolidated financial statements for the year ended December 31, 2003, that it expected to contribute $650,000 to its pension plan in 2004.  A contribution of $581,000 was paid during the third quarter, 2004.  It is expected that approximately $45,000 in additional contributions will be made during the fourth quarter, 2004.


- 12 -















INDEPENDENT  ACCOUNTANTS'  REVIEW  REPORT




To the Board of Directors and Shareholders

LCNB Corp. and subsidiaries

Lebanon, Ohio



We have reviewed the accompanying consolidated balance sheet of LCNB Corp. and subsidiaries as of September 30, 2004, and the related consolidated statements of income and comprehensive income for each of the three-month and nine-month periods ended September 30, 2004 and 2003, and the related consolidated statements of cash flows and shareholders' equity for each of the nine-month periods ended September 30, 2004 and 2003.  These financial statements are the responsibility of the Company's management.


We conducted our review in accordance with the standards of The Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of The Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.


Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with U.S. generally accepted accounting principles.


We previously audited, in accordance with the standards of The Public Company Accounting Oversight Board (United States), the consolidated balance sheet of LCNB Corp. and subsidiaries as of December 31, 2003 (presented herein), and the related consolidated statements of income, shareholders' equity, and cash flows for the year then ended (not presented herein), and in our report dated January 16, 2004, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2003, is fairly stated in all material respects.





/s/ J.D. Cloud & Co. L.L.P.                                      



Cincinnati, Ohio

October 15 , 2004



- 13 -












LCNB Corp. and Subsidiaries


Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations


Forward Looking Statements

Certain matters disclosed herein may be deemed to be forward-looking statements that involve risks and uncertainties, including regulatory policy changes, interest rate fluctuations, loan demand, loan delinquencies and losses, and other risks.  Actual strategies and results in future time periods may differ materially from those currently expected.  Such forward-looking statements represent management's judgment as of the current date.  The Company disclaims, however, any intent or obligation to update such forward-looking statements.


Results of Operations

LCNB earned $1,582,000, or $0.47 per share, for the three months ended September 30, 2004 compared to $1,526,000, or $0.45 per share, for the three months ended September 30, 2003.  The return on average assets (ROAA) was 1.23% and the return on average equity (ROAE) was 12.11% for the third quarter of 2004, compared with an ROAA of 1.17% and an ROAE of 11.33% for the third quarter of 2003.  The increase in net income is primarily due to increases in trust income and income from service charges and fees, partially offset by a reduction in gains from sales of mortgage loans.


LCNB earned $4,800,000, or $1.43 per share, during the first nine months of 2004 compared to $4,830,000, or $1.41 per share, for the first nine months of 2003.  The ROAA and ROAE for the first nine months of 2004 were 1.26% and 12.21%, respectively.  The comparable ratios for the first nine months of 2003 were 1.25% and 12.12%, respectively.  The decrease in net income for the nine month period was primarily attributable to reductions in net interest income and gains from sales of mortgage loans.  Partially offsetting these influences were increases in trust income, income from service charges and fees, and gains from sales of investment securities and LCNB’s credit card portfolio during 2004 .


LCNB's earnings for the first nine months of 2004 included $539,000, or $356,000 on an after-tax basis, in gains from sales of investment securities totaling $15.9 million and credit card receivables totaling approximately $2.5 million.  The proceeds from the sale of investment securities were primarily used to purchase securities with a slightly longer maturity and higher average interest rates than the ones sold.  LCNB management decided to exit the credit card market and sell its receivables to MBNA America because of the high administrative costs of servicing a small credit card portfolio.  LCNB will continue to offer credit card products under a marketing agreement with MBNA.



Net Interest Income


Three Months Ended September 30, 2004 vs. 2003.

LCNB's primary source of earnings is net interest income, which is the difference between earnings from loans and other investments and interest paid on deposits and other liabilities.  The following table presents, for the three months ended September 30, 2004 and 2003, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resultant average yields earned or rates paid.



- 14 -












LCNB Corp. and Subsidiaries


Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


 

Three Months Ended September 30,

 

2004

 

2003

 

Average

 

Interest

 

Average

 

Average

 

Interest

 

Average

 

Outstanding

 

Earned/

 

Yield/

 

Outstanding

 

Earned/

 

Yield/

 

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

 

(Dollars in thousands)

                      

Loans (1)

$

333,352 

  

$

5,188

  

6.17%

  

$

318,357 

  

$

5,329

  

6.64%

 

Federal funds sold

 

8,252

   

28

  

1.35%

   

17,016 

   

40

  

0.93%

 

Federal Reserve Bank stock

 

647 

   

 -

  

    -%

   

647 

   

 -

  

    -%

 

Federal Home Loan Bank stock

 

2,361 

   

25

  

4.20%

   

2,269 

   

23

  

4.02%

 

Investment securities:

                     

   Taxable

 

83,395 

   

734

  

3.49%

   

90,769 

   

741

  

3.24%

 

   Non-taxable (2)

 

51,540 

   

733

  

5.64%

   

59,304 

   

806

  

5.39%

 

       Total interest-earning assets

 

479,547 

   

6,708

  

5.55%

   

488,362 

   

6,939

  

5.64%

 

Non-earning assets

 

33,299 

          

33,229 

        

Allowance for loan losses

 

(2,160)

          

(2,031)

        

      Total assets

$

510,686 

         

$

519,560 

        
                      

Interest-bearing deposits

$

376,460 

   

1,771

  

1.87%

   

390,455 

   

1,978

  

2.01%

 

Short-term debt

 

529 

   

2

  

1.50%

   

731 

   

2

  

1.09%

 

Long-term debt

 

4,160 

   

53

  

5.05%

   

6,218 

   

72

  

4.59%

 

      Total interest-bearing liabilities

 

381,149 

   

1,826

  

1.90%

   

397,404 

   

2,052

  

2.05%

 

Demand deposits

 

75,157 

          

65,147 

        

Other liabilities

 

2,549 

          

3,560 

        

Capital

 

51,831 

          

53,449 

        

      Total liabilities and capital

$

510,686 

         

$

519,560 

        
                      

Net interest rate spread (3)

        

3.65%

          

3.59%

 
                      

Net interest income and net

                     

   interest margin on a taxable

                     

    equivalent basis (4)

    

$

4,882

  

4.04%

      

$

4,887

  

3.97%

 
                      

Ratio of interest-earning assets

                     

   to interest-bearing liabilities

 

125.82%

          

122.89%

        



(1)

Includes nonaccrual loans if any.  Income from tax-exempt loans is included in interest income on a tax-equivalent basis, using an incremental rate of 34%.

(2)

Income from tax-exempt securities is included in interest income on a taxable-equivalent basis.  Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34%.

(3)

The net interest rate spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities.

(4)

The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.



- 15 -












LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


The following table presents the changes in taxable-equivalent basis interest income and expense for each major category of interest-earning assets and interest-bearing liabilities and the amount of change attributable to volume and rate changes for the three months ended September 30, 2004 as compared to the comparable period in 2003.  Changes not solely attributable to rate or volume have been allocated to volume and rate changes in proportion to the relationship of absolute dollar amounts of the changes in each.


   

Three Months Ended

 
   

September 30,

 
   

2004 vs. 2003

 
   

Increase (decrease) due to:

 
  

Volume

 

Rate

  

Total

 
   

(In thousands)

 

Interest-earning Assets:

          

   Loans

 

$

244

  

(385)

  

(141)

 

   Federal funds sold

  

(26)

  

14 

  

(12)

 

   Federal Reserve Bank stock

  

  

  

 

   Federal Home Loan Bank stock

  

  

  

 

   Investment securities:

          

     Taxable

  

(63)

  

56 

  

(7)

 

     Nontaxable

  

(109)

  

36 

  

(73)

 

        Total interest income

  

47 

  

(278)

  

(231)

 
           

Interest-bearing Liabilities :

          

   Deposits

  

(69)

  

(138)

  

(207)

 

   Short-term borrowings

  

(1)

  

  

 

   Long-term debt

  

(26)

  

  

(19)

 

        Total interest expense

  

(96)

  

(130)

  

(226)

 

           Net interest income

 

$

143 

  

(148)

  

(5)

 



- 16 -













LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


Net interest income on a fully tax-equivalent basis for the three months ended September 30,  2004 totaled $4,882,000, a decrease of $5,000 from the comparable period in 2003.  Total interest income decreased $231,000 and was largely offset by a decrease in total interest expense of $226,000.  


The decrease in total interest income was primarily due to a 9 basis point (a basis point equals 0.01%) reduction in the average rate earned on earning assets, from 5.64% for the third quarter of 2003 to 5.55% for the third quarter of 2004.  A secondary factor was an $8.9 million decrease in average interest earning assets, from $488.4 million for the three months ended September 30, 2003 to $479.5 million for the same period in 2004.  Most of the decrease was in federal funds sold and investment securities, largely offset by $15.0 million increase in average loans.


The decrease in total interest expense was due to a 15 basis point decrease in the average rate paid and to a $16.3 million decrease in average interest-bearing liabilities.  Average interest-bearing deposits decreased $14.0 million, while average long-term debt decreased $2.1 million.  The deposit decrease was primarily in money fund investment and certificate of deposit accounts.  The decrease in long-term debt was due to the maturation of a $2.0 million Federal Home Loan Bank advance in December, 2003.


Nine Months Ended September 30, 2004 vs. 2003.

The following table presents, for the nine months ended September 30, 2004 and 2003, average balances for interest-earning assets and interest-bearing liabilities, the income or expense related to each item, and the resultant average yields earned or rates paid.



- 17 -












LCNB Corp. and Subsidiaries


Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


 

Nine Months Ended September 30,

 

2004

 

2003

 

Average

 

Interest

 

Average

 

Average

 

Interest

 

Average

 

Outstanding

 

Earned/

  

Yield/

  

Outstanding

 

Earned/

 

Yield/

 

Balance

 

Paid

  

Rate

  

Balance

 

Paid

 

Rate

 

(Dollars in thousands)

                      

Loans (1)

$

324,339 

  

$

15,254

  

6.28%

  

$

321,104 

  

$

16,646

  

6.93%

 

Federal funds sold

 

11,881 

   

94

  

1.06%

   

16,569 

   

132

  

1.07%

 

Federal Reserve Bank stock

 

647 

   

19

  

3.92%

   

647 

   

19

  

3.93%

 

Federal Home Loan Bank stock

 

2,338 

   

72

  

4.11%

   

2,247 

   

68

  

4.05%

 

Investment securities:

                     

   Taxable

 

85,413 

   

2,204

  

3.45%

   

84,834 

   

2,245

  

3.54%

 

   Non-taxable (2)

 

52,326 

   

2,208

  

5.64%

   

58,418 

   

2,417

  

5.53%

 

       Total interest-earning assets

 

476,944 

   

19,851

  

5.56%

   

483,819 

   

21,527

  

5.95%

 

Non-earning assets

 

33,286 

          

33,013 

        

Allowance for loan losses

 

(2,159)

          

(2,013)

        

      Total assets

$

508,071 

         

$

514,819 

        
                      

Interest-bearing deposits

$

375,563 

   

5,274

  

1.88%

   

388,155 

   

6,489

  

2.24%

 

Short-term debt

 

511 

   

4

  

1.05%

   

659 

   

5

  

1.01%

 

Long-term debt

 

4,174 

   

158

  

5.06%

   

6,232 

   

211

  

4.53%

 

      Total interest-bearing liabilities

 

380,248 

   

5,436

  

1.91%

   

395,046 

   

6,705

  

2.27%

 

Demand deposits

 

72,597 

          

63,142 

        

Other liabilities

 

2,732 

          

3,360 

        

Capital

 

52,494 

          

53,271 

        

      Total liabilities and capital

$

508,071 

         

$

514,819 

        
                      

Net interest rate spread (3)

        

3.65%

          

3.68%

 
                      

Net interest income and net interest

                     

   margin on a taxable equivalent

                     

    basis (4)

    

$

14,415

  

4.04%

      

$

14,822

  

4.10%

 
                      

Ratio of interest earning assets

                     

   to interest -bearing liabilities

 

125.43%

          

122.47%

        
                      


(1)

Includes nonaccrual loans if any.  Income from tax-exempt loans is included in interest income on a tax-equivalent basis, using an incremental rate of 34%.

(2)

Income from tax-exempt securities is included in interest income on a taxable-equivalent basis.  Interest income has been divided by a factor comprised of the complement of the incremental tax rate of 34%.

(3)

The net interest rate spread is the difference between the average rate on total interest-earning assets and interest-bearing liabilities.

(4)

The net interest margin is the taxable-equivalent net interest income divided by average interest-earning assets.



-18-












LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


The following table presents the changes in taxable-equivalent basis interest income and expense for each major category of interest-earning assets and interest-bearing liabilities and the amount of change attributable to volume and rate changes for the nine months ended September 30, 2004 as compared to the comparable period in 2003.  


   

Nine Months Ended

 
   

September 30,

 
   

2004 vs. 2003

 
   

Increase (decrease) due to:

 
  

Volume

 

Rate

  

Total

 
   

(In thousands)

 

Interest-earning Assets:

          

   Loans

 

$

166 

  

(1,558)

  

(1,392)

 

   Federal funds sold

  

(37)

  

(1)

  

(38)

 

   Federal Reserve Bank stock

  

  

  

 

   Federal Home Loan Bank stock

  

  

  

 

   Investment securities:

          

     Taxable

  

15 

  

(56)

  

(41)

 

     Nontaxable

  

(256)

  

47 

  

(209)

 

        Total interest income

  

(109)

  

(1,567)

  

(1,676)

 
           

Interest-bearing Liabilities :

          

   Deposits

  

(205)

  

(1,010)

  

(1,215)

 

   Short-term borrowings

  

(1)

  

  

(1)

 

   Long-term debt

  

(76)

  

23 

  

(53)

 

        Total interest expense

  

(282)

  

(987)

  

(1,269)

 

           Net interest income

 

$

173 

  

(580)

  

(407)

 


Net interest income on a fully tax-equivalent basis for the first nine months of 2004 totaled $14,415,000, a decrease of $407,000 from the same period in 2003.  Total interest income decreased $1,676,000 and was partially offset by a decrease in total interest expense of $1,269,000.


The decrease in total interest income was primarily due to a 39 basis point decrease in the average rate earned on earning assets, from 5.95% for the nine months ended September 30, 2003 to 5.56% for the same period in 2004.  A secondary factor was a $6.9 million decrease in average total earning assets.  



- 19 -












LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


The decrease in total interest expense was primarily due to a 36 basis point decrease in the average rate paid, and secondarily to a $14.8 million decrease in average interest-bearing liabilities.  Average interest-bearing deposits decreased $12.6 million and average long-term debt decreased $2.1 million.  As discussed in the previous section, the deposit decrease was primarily in money fund investment and certificate of deposit accounts and the decrease in long-term debt was due to the maturation of a $2.0 million Federal Home Loan Bank advance in December, 2003.


Provision and Allowance For Loan Losses

The total provision for loan losses is determined based upon management's evaluation as to the amount needed to maintain the allowance for credit losses at a level considered appropriate in relation to the risk of losses inherent in the portfolio.  The total loan loss provision and the other changes in the allowance for loan losses are shown below.  


  

Quarter Ended

 

Nine Months Ended

  

September 30,

 

September 30,

  

2004

 

2003

 

2004

 

2003

  

(In thousands)

         

Balance, beginning of period

$

2,150

 

2,003

 

2,150

 

2,000

         

   Charge-offs

 

172

 

137

 

530

 

385

   Recoveries

 

42

 

 5

 

100

 

39

      Net charge-offs

 

130

 

132

 

430

 

346

         

Provision for loan losses

 

130

 

204

 

430

 

421

         

Balance, end of period

$

2,150

 

2,075

 

2,150

 

2,075



Charge-offs for the first nine months of 2004 included a $126,000 charge-off on a commercial loan, $32,000 in residential real estate mortgage loan charge-offs,  $362,000 in consumer loan charge-offs, and $10,000 in credit card charge-offs.  Charge-offs for the same period in 2003 included $366,000 in consumer loan charge-offs and $19,000 in credit card charge-offs.



- 20 -












LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


The following table sets forth information regarding the past due, non-accrual and renegotiated loans of the Bank at the dates indicated:


  

September 30,

 

December 31,

   

2004

   

2003

 
   

(In thousands)

         

Loans accounted for on non-accrual basis

 

$

1,817

   

794

 

Accruing loans which are past due 90 days or more

  

153

   

2,442

 

Renegotiated loans

  

-

   

-

 

     Total

 

$

1,970

   

3,236

 



Non-accrual loans at September 30, 2004 included $1,817,000 of related commercial loans that were classified as loans past due 90 days or more and still accruing at December 31, 2003, at which time they had a balance of $2,030,000.  The $213,000 difference in the loan balances at September 30, 2004 and December 31, 2003 is due to principal payments received.  These loans are secured by a combination of mortgages and other collateral.  Information received during the first quarter, 2004 raised uncertainties concerning the collectibility of certain collateral and management transferred the loans to the nonaccrual classification and wa s continuing to classify the loans as non-accrual at September 30, 2004 .  All related interest due on the loans was paid during October, 2004 and the loans were re-written at that time.  Such interest has been recorded on a cash basis as received.



Non-accrual loans at December 31, 2003 included a commercial loan in the amount of $564,000, which was paid in full during the second quarter, 2004.



Non -Interest Income


Three Months Ended September 30, 2004 vs. 2003.

Total non-interest income for the third quarter of 2004 was $46,000 or 2.7% greater than for the third quarter of 2003 primarily due to increased service charges and fees and increased trust income, partially offset by decreased gains from loan sales from reduced activity in the real estate mortgage loan secondary market.  Service charges and fees increased $153,000 or 18.5% primarily due to an increase in the number of non-sufficient fund charges.  Trust income was $97,000 or 36.2% greater primarily due to growth in total trust assets, from $129.2 million at September 30, 2003 to $174.0 million at September 30, 2004.  This growth was primarily from new business.


Gains from sales of mortgage loans decreased $228,000 or 97.9% due to a decrease in the volume of loans sold during the third quarter, 2004 as compared to the third quarter, 2003.  The volume of residential mortgage loan refinancing has declined with the recent increase in market rates.  LCNB is also holding a greater percentage of new loans in its loan portfolio rather than selling them in the secondary market.  See Note 4 to the consolidated financial statements for a comparison of loans sold during the three and nine months ended September 30, 2004 and 2003.



- 21 -












LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


Nine Months Ended September 30, 2004 vs. 2003.

Total non-interest income for the first nine months of 2004, excluding the investment security and credit card gains, was $30 9 ,000 or 6. 4 % more than for the comparable period in 2003 primarily due to a $684,000 or 31.6% increase in service charges and fees and a $323,000 or 42.7% increase in trust income, partially offset by a $688,000 or 93.6% decrease in gains from sales of mortgage loans.  Service charges and fees and trust income increased and gains from sales of mortgage loans decreased for substantially the same reasons mentioned above.



Non-Interest Expense


Three Months Ended September 30, 2004 vs. 2003.

Total non-interest expense increased $15,000 or 0.4% during the third quarter, 2004 compared with the third quarter, 2003 primarily due to increases in pension and other employee benefits and occupancy expenses.  Pension and other employee benefits increased $36,000 or 8.6% primarily due to increased pension expense and an increase in social security and Medicare matching.  Occupancy expense increased $22,000 or 7.8% primarily due to increased maintenance and repair expenses, increased office rental expense, and increased depreciation of bank premises.


Nine Months Ended September 30, 2004 vs. 2003.

Total non-interest expense increased $482,000 or 4.1% during the first nine months of 2004 compared with the first nine months of  2003 primarily due to an $84,000 or 1.6% increase in salaries and wages, a $102,000 or 7.8% increase in pension and other employee benefits, a $70,000 or 8.4% increase in occupancy expense, and a $133,000 or 5.4% increase in other non-interest expenses.  The increase in salaries and wages was primarily due to routine salary and wage increases.  Pension and other employee benefits increased for substantially the same reasons described in the third quarter comparison above.  Approximately $29,000 of the increase in occupancy expense was due to increased maintenance and repair expenses, and the rest was due to smaller increases in several different occupancy classifications.  Items contributing to the increase in other non-interest expenses included maintenance contracts on computer software,  telephone expense, and outside services.


Income Taxes

LCNB’s effective tax rates for the nine months ended September 30, 2004 and 2003 were 27.0% and 26.3%, respectively.  The difference between the statutory rate of 34.0% and the effective tax rate is primarily due to tax-exempt interest income.   



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LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


Financial Condition

Loans at September 30, 2004 were approximately $18.5 million greater than at December 31, 2003.  The growth can be primarily attributed to the residential real estate loan portfolio, which was $14.3 million greater at September 30, 2004 than at December 31, 2003.  The portfolio grew because, with the recent increase in market rates for residential real estate loans, LCNB is adding a greater percentage of new loans generated to its loan portfolio rather than selling them in the secondary market.  Growth in the Homeline home equity loan portfolio and the commercial loan portfolio also contributed to the increase.  


Interest-bearing deposits at September 30, 2004 were approximately $11.6 million less than at December 31, 2003.  The decrease is due to a new $15.5 million trust account that was obtained near year end, 2003.  The funds were temporarily deposited in a liquid, interest-bearing account at Lebanon Citizens until the trust department could invest them in other instruments during early 2004.



- 23 -












LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


The following table highlights the changes in the balance sheet. The analysis uses quarterly averages to give a better indication of balance sheet trends.  


  

CONDENSED QUARTERLY AVERAGE

 
  

BALANCE SHEETS

 
 

September 30,

 

June 30

 

March 31,

  

2004

   

2004

   

2004

 
  

(In thousands)

 

ASSETS

           

  Interest earning:

           

    Federal funds sold

$

8,252

   

13,225 

   

14,206 

 

    Investment securities

 

137,94 3

   

139,574 

   

144,686 

 

    Loans

 

333,352

   

321,502 

   

318,089 

 

      Total interest-earning assets

 

479,54 7

   

474,301 

   

476,981 

 
            

  Noninterest-earning:

           

    Cash and due from banks

 

14,153

   

13,653 

   

13,992 

 

    All other assets

 

19,146

   

19,353 

   

19,512 

 

    Allowance for credit losses

 

(2,160)

   

(2,164)

   

(2,153)

 

        TOTAL ASSETS

$

510,68 6

   

505,143 

   

508,332 

 
            

LIABILITIES

           

  Interest-bearing:

           

    Interest-bearing deposits

$

376,460

   

372,130 

   

378,089 

 

    Short-term borrowings

 

529

   

573 

   

430 

 

    Long-term debt

 

4,160

   

4,175 

   

4,189 

 

      Total interest-bearing liabilities

 

381,149

   

376,878 

   

382,708 

 
            

  Noninterest-bearing:

           

    Noninterest-bearing deposits

 

75,157

   

72,933 

   

69,571 

 

    All other liabilities

 

2,5 49

   

2,708 

   

3,017 

 

        TOTAL LIABILITIES

 

458,856

   

452,519 

   

455,296 

 
            

SHAREHOLDERS' EQUITY

 

51,831

   

52,624 

   

53,036 

 
            

        TOTAL LIABILITIES AND

          SHAREHOLDERS' EQUITY


$


510,68 6

   


505,143 

   


508,332 

 
            



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LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


Average total interest-earning assets increased approximately $5.2 million or 1.1% during the third quarter, 2004 compared to the second quarter, 2004.  The increase was due to growth in the loan portfolio, which increased $11.9 million on an average basis.  This growth was primarily attributable to growth in the residential mortgage loan and commercial loan portfolios.  The growth in the loan portfolio was partially offset by decreases in average federal funds sold and investment securities.  


Average total interest-bearing liabilities for the third quarter, 2004, were $4.3 million or 1.1% greater than for the second quarter, 2004.  The increase was primarily in interest-bearing deposits, which increased $4.3  million on an average basis.  Certificate of deposit accounts equal to or greater than $100,000, savings accounts, and IRA accounts increased $5.0 million, $1.3 million, and $1.5 million, respectively, on an average basis.  During the same period, money fund investment accounts and certificate of deposit accounts less than $100,000 decreased $2.2 million and $1.3 million, respectively, on an average basis.


Capital

Lebanon Citizens and LCNB are required by regulators to meet certain minimum levels of capital adequacy. These are expressed in the form of certain ratios. Capital is separated into Tier 1 capital (essentially shareholders' equity less goodwill and other intangibles) and Tier 2 capital (essentially the allowance for loan losses limited to 1.25% of risk-weighted assets). The first two ratios, which are based on the degree of credit risk in LCNB's assets, provide for weighting assets based on assigned risk factors and include off-balance sheet items such as loan commitments and stand-by letters of credit. The ratio of Tier 1 capital to risk-weighted assets must be at least 4.0% and the ratio of Total capital (Tier 1 capital plus Tier 2 capital) to risk-weighted assets must be at least 8.0%.  The capital leverage ratio supplements the risk-based capital guidelines. Banks are required to maintain a minimum ratio of Tier 1 capital to adjusted quarterly average total assets of 3.0%. For various regulatory purposes, financial institutions are classified into categories based upon capital adequacy.  The highest "well-capitalized" category requires capital ratios of at least 10% for total risk-based, 6% for Tier 1 risk-based, and 5% for leverage.  As of the most recent notification from their regulators, Lebanon Citizens and LCNB were categorized as "well-capitalized" under the regulatory framework for prompt corrective action.  Management believes that no conditions or events have occurred since the last notification that would change the Lebanon Citizens' or LCNB's category.  A summary of the regulatory capital and capital ratios of LCNB follows:



- 25 -












LCNB Corp. and Subsidiaries



Item 2. Management's Discussion and Analysis of Financial Condition and Results of

Operations (continued)


  

At

 

At

  

September 30,

 

December 31,

   

2004

   

2003

 
  

(Dollars in thousands)

Regulatory Capital:

        

   Shareholders' equity

 

$

52,086 

   

52,448 

 

   Goodwill and other intangibles

  

(2,089)

   

(2,550)

 

   Net unrealized securities losses (gains)

  

(1,068)

   

(1,819)

 

      Tier 1 risk-based capital

  

48,929 

   

48,079 

 
         

   Eligible allowance for loan losses

  

2,150 

   

2,150 

 

      Total risk-based capital

 

$

51,079 

   

50,229 

 
         

Capital ratios:

        

   Total risk-based

  

15.5 6 %

   

15.58%

 

   Tier 1 risk-based

  

14. 91 %

   

14.91%

 

   Leverage

  

9.63%

   

9.34%

 
         

Minimum Requited Capital Ratios:

        

   Total risk-based

  

8.00%

   

8.00%

 

   Tier 1 risk-based

  

4.00%

   

4.00%

 

   Tier 1 leverage

  

3.00%

   

3.00%

 



- 26 -












LCNB Corp. and Subsidiaries



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of

Operations (continued)


Liquidity

LCNB depends on dividends from its subsidiaries for the majority of its liquid assets, including the cash needed to pay dividends to its shareholders.  National banking law limits the amount of dividends Lebanon Citizens may pay to the sum of retained net income, as defined, for the current year plus retained net income for the previous two years.  Prior approval from the Office of the Comptroller of the Currency, Lebanon Citizens’ primary regulator, is necessary for Lebanon Citizens to pay dividends in excess of this amount.  In addition, dividend payments may not reduce capital levels below minimum regulatory guidelines.  Management believes Lebanon Citizens will be able to pay anticipated dividends to LCNB without needing to request approval.


Liquidity is the ability to have funds available at all times to meet the commitments of LCNB.  Asset liquidity is provided by cash and assets which are readily marketable or pledgeable or which will mature in the near future. Liquid assets include cash, federal funds sold and securities available for sale.  At September 30, 2004, LCNB liquid assets amounted to $162.3 million or 31.3% of total gross assets, a decrease from $185.3 million or 35.4% at December 31, 2003.




Liquidity is also provided by access to core funding sources, primarily core depositors in the bank’s market area.  Approximately 87.0% of total deposits at September 30, 2004 were “core” deposits.  Core deposits, for this purpose, are defined as total deposits less public funds and certificates of deposit greater than $100,000.  


Secondary sources of liquidity include LCNB’s ability to sell loan participations, borrow funds from the Federal Home Loan Bank, purchase federal funds, and borrow funds from its Federal Reserve Primary Line.  Management closely monitors the level of liquid assets available to meet ongoing funding needs.  It is management’s intent to maintain adequate liquidity so that sufficient funds are readily available at a reasonable cost.  LCNB experienced no liquidity or operational problems as a result of the current liquidity levels.


- 27 -












LCNB Corp. and Subsidiaries



Item 3.  Quantitative and Qualitative Disclosures about Market Risks


For a discussion of LCNB's asset and liability management policies and gap analysis for the year ended December 31, 2003 see Item 7A, Quantitative and Qualitative Disclosures about Market Risks, in the Form 10-K for the year ended December 31, 2003.  There have been no material changes in LCNB's market risks, which for LCNB is primarily interest rate risk.



Item 4.  Controls and Procedures


a)  Disclosure controls and procedures.  The Chief Executive Officer and the Chief Financial Officer have carried out an evaluation of the effectiveness of LCNB's disclosure controls and procedures that ensure that information relating to LCNB required to be disclosed by LCNB in the reports that it files or submits under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.  Based upon this evaluation, these officers have concluded, that as of September 30, 2004, LCNB's disclosure controls and procedures were adequate.


b)  Changes in internal control over financial reporting.  During the period covered by this report, there were no changes in LCNB's internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, LCNB's internal control over financial reporting.



- 28 -












PART II.  OTHER INFORMATION


LCNB Corp. and Subsidiaries



Item 1. Legal Proceedings - Not Applicable



Item 2. Changes in Securities and Use of Proceeds


On April 17, 2001, LCNB's Board of Directors authorized three separate stock repurchase programs, two phases of which continue.  The shares purchased will be held for future corporate purposes.


Under the "Market Repurchase Program" LCNB will purchase up to 100,000 shares of its stock through market transactions with a selected stockbroker.  Through September 30, 2004, 59,531 shares had been purchased under this program.  The following table shows information relating to the repurchase of shares under the Market Repurchase Program during the nine months ended September 30, 2004:



     

Total Number of

 

Maximum

     

Shares

 

Number of

     

Purchased as

 

Shares that May

 

Total

   

Part of Publicly

 

Yet Be

 

Number of

 

Average

 

Announced

 

Purchased

 

Shares

 

Price Paid

 

Plans or

 

Under the Plans

 

Purchased

 

Per Share

 

Programs

 

or Programs

        

January

 

-

  

$

-

   

-

   

67,846

 

February

 

1,948

   

36.08

   

1,948

   

65,898

 

March

 

-

   

-

   

-

   

65,898

 

April

 

-

   

-

   

-

   

65,898

 

May

 

7,122

   

37.32

   

7,122

   

58,776

 

June

 

-

   

-

   

-

   

58,776

 

July

 

3,300

   

37.00

   

3,300

   

55,476

 

August

 

15,007

   

37.50

   

15,007

   

40,469

 

September

 

-

   

-

   

-

   

40,469

 

   Total

 

27,377

  

$

37.29

   

27,377

   

40,469

 
                


The "Private Sale Repurchase Program" is available to shareholders who wish to sell large blocks of stock at one time.  Because LCNB's stock is not widely traded, a shareholder releasing large blocks may not be able to readily sell all shares through normal procedures.  Purchases of blocks will be considered on a case-by-case basis and will be made at prevailing market prices.  There is no limit to the number of shares that may be purchased under this program.  A total of 160,144 shares have been purchased under this program since its inception.  The following table shows information relating to private sale repurchases during the nine months ended September 30, 2004:



- 29 -













PART II.  OTHER INFORMATION


LCNB Corp. and Subsidiaries



Item 2. Changes in Securities and Use of Proceeds (continued)


     

Total Number of

 

Maximum

     

Shares

 

Number of

     

Purchased as

 

Shares that May

 

Total

   

Part of Publicly

 

Yet Be

 

Number of

 

Average

 

Announced

 

Purchased

 

Shares

 

Price Paid

 

Plans or

 

Under the Plans

 

Purchased

 

Per Share

 

Programs

 

or Programs

        

January

 

-

  

$

-

   

-

  

Not applicable

February

 

-

   

-

   

-

   

March

 

-

   

-

   

-

   

April

 

-

   

-

   

-

   

May

 

4,000

   

37.50

   

4,000

   

June

 

11,700

   

37.50

   

11,700

   

July

 

-

   

-

   

-

   

August

 

-

   

-

   

-

   

September

 

-

   

-

   

-

   

   Total

 

15,700

  

$

37.50

   

15,700

   
              



Item 3. Defaults Upon Senior Securities - Not Applicable



Item 4. Submission of Matters to a Vote of Security Holders  - Not Applicable



Item 5. Other Information - Not Applicable






- 30 -













PART II.  OTHER INFORMATION


LCNB Corp. and Subsidiaries





Item 6. Exhibits and Reports on Form 8-K


(a)

Exhibits

  
    
 

Exhibit No.

 

Title

 

  3(i)

 

Articles of Incorporation – incorporated by reference to the Company’s

   

1999 Form 10-K, Exhibit 3.1.

    
 

  3(ii)

 

By-Laws – incorporated by reference to the Company’s Registration

   

Statement on Form S-4, Exhibit 3.2, Registration No. 333-70913.

    
 

  15

 

Letter regarding unaudited interim financial information.

    
 


 


   


   


    
 

  31.1

 

Certification of Chief Executive Officer under Section 302 of the

   

Sarbanes-Oxley Act of 2002.

    
 

  31.2

 

Certification of Chief Financial Officer under Section 302 of the

   

Sarbanes-Oxley Act of 2002.

    
 

  32

 

Certification of Chief Executive Officer and Chief Financial Officer

   

under Section 906 of the Sarbanes-Oxley Act of 2002.

    

(b)

Reports on Form 8-K

 

  Form 8-K dated July 15, 2004, reporting under Item 9 and Item 12 the issuance of a press

  release announcing earnings of LCNB for the six months ended June 30, 2004.


  Form 8-K dated July 1, 2004, reporting under Item 5 the issuance of press release

  announcing the appointment of Joseph W. Schwarz to LCNB’s Board of Directors.

  



- 31 -













SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.




LCNB Corp.


October 28, 2004

/s/ Stephen P. Wilson


Stephen P. Wilson, President, CEO &

Chairman of the Board of Directors



October 28, 2004

/s/Steve P. Foster


Steve P. Foster, Executive Vice President

and Chief Financial Officer



- 32 -